Please Stop With the “Cutting IOER Will Increase Lending” Madness…

It’s become extremely fashionable in recent weeks and months for analysts and economists to propose cutting the Interest On Excess Reserves based on the assumption that this will suddenly stimulate lending and help the Fed gain some traction on the policy front.  This is extremely misleading in my opinion and often times based on a total misunderstanding of how modern banking works (see here for instance).

First of all, banks have eased lending standards substantially.  The latest Senior Loan Officer Opinion Survey on Bank Lending Practices showed that lending standards have eased considerably in recent years:



Okay, so if banks are flush with reserves, as profitable as ever and lending standards are low then what could be the problem?  Well, it must be a demand side problem then.  And the data confirms this.  The latest survey shows that demand for loans is still relatively weak:



This makes sense considering that households only JUST reported their first year over year increase in debt accumulation in the last 5 years:



The lack of lending and increase in the broad money supply from loan creation is the direct result of a lack of demand.  It is not the result of supply side issues.  Reducing the IOER is not going to increase demand for loans.  You can’t fix a demand side problem of this type with supply side fixes so please, let’s stop with this “reduce the IOER” madness.


Understanding the Modern Monetary System

The Money Multiplier is a Myth

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  1. From above:

    “Odie says:

    12/16/2013 at 11:33 PM

    It would stop sending the Treasury its annual check (and pay dividends to its member banks for the Fed). Otherwise, a CB cannot go illiquid by definition.

    Interest rate targeting may become more problematic since the Fed has lost assets it could usually use to perform OMOs. I doubt, however, that would be serious.”

    I think there would be other effects, but too long to get into now.

  2. I agree the effect won’t be huge, but saying it won’t increase lending at all is a bit too harsh in my opinion.

    Do we even need increased lending? Inflation may not be a huge problem but it’s definitely there. M2 has been going up too… I would like to see statistics on this, but I bet a major portion of the increased loans would be made to consumers, who would then buy goods made overseas. That’s exactly what is not needed, if I am correct.

  3. Odie says:

    12/17/2013 at 12:51 AM

    Sure we can change the system. Who is producing the money then and how does it get into circulation?

    Something equivalent to the Bureau of Engraving and Printing;

    Use it to pay a risk free interest rate to savers;

    • Sounds like you want to have the government just print the money and spend it without recording it as debt. Plus, where is the money coming from that the interest payments are being paid for in the first place?

      Taking a step back:
      Let’s assume we want to design a completely new, “ideal” monetary system; how would that look like? A few thoughts of mine: First, the goal of an economy is to provide the goods and services for our survival (with the survival of our species being the ultimate biological goal of our existence). How can we use money to support that goal? How for example would savings be helpful in achieving that?

      Would almost be worthwhile discussing that in a new thread.